Bankruptcy

Should I settle some debts before bankruptcy

By Cathy Moran, California Bankruptcy Lawyer

Two of his creditors were willing to settle the debt for a substantial discount, my client reported.  Could he accept a reduced payoff before he filed bankruptcy?

There is no bar to compromising with creditors before a bankruptcy filing.  Debtors under California state law are free to pay one creditor over another.  The Bankruptcy Code’s preference statute impacts the recipient of a pre petition payment not the debtor who made the payment.  So, from a legal point of view, the client was good to go.

But had he considered the tax impact of the settlement, I asked.  The amount of the discounted debt will be reported to the IRS as income.  (It may not result in a tax due, depending on other issues.)

But, more importantly, what was the point of settling a debt before bankruptcy?  Settlement, in my view, is useful only if it allows the debtor to avoid bankruptcy.  And my experience in achieving a meaningful settlement with all of a client’s creditors is dismal:  some creditor with a big claim is always a hold out.

My advice:  find a better use for the thousands the settlement called for.  Fund an IRA, repair your car, buy health insurance.  There are any number of ways those funds could be a step toward a more stable life after the bankruptcy.

Full post as published by Bankruptcy Law Network on February 23, 2010 (boomark / email).